Small Business Blog

March 2011

Cash Flow

Cash flow is your business oxygen. Without it, your business will suffocate and die. In this blog, and the next few, I want to share with you some ideas and ways to increase cash flow and profitibility.

The first thing to consider in the process is creating adequate and consistent cash flow. A cash flow crunch is usually the result of poor planning. All businesses have business cycles and they must be planned for. Starbucks knows that coffee sales go up in the winter and down in the summer. In the summer then, they introduce icy drinks to keep the cash flowing. The same should be true for you. You must know your business cycle, know when times should be good and bad, and plan accordingly.

So, another reason to create a budget (aside from the ones I mentioned in a previous blog) is to ensure that you will have adequate cash flow. I can't say this any more plainly: Without consistent, sufficient money to buy inventory, pay bills, handle taxes, handle payroll, and pay yourself, you will go out of business. Preserving and defending your cash flow therefore is critical.

Aside from creating a budget, here are three more ways to control your cash flow:

Live by the Rule: Without your business oxygen, your business will suffocate and die. Cash flow is king.

Create Cash Flow Projections: You need to know what will come in and when. Realistic cash flow projections are key. The question is: What do you expect your cash balance to be in six months? Always know that number.

Keep the Pipeline Open: A client or customer you create today may hire you, but it may be a few months before you finish the work and send out a bill, and it may be another month or two before they pay. You have to keep creating clients and doing work today to keep the cash flow spigot open.

Always project three to six months ahead when it comes to cash flow. If you will need money in six months, you must create new business within the next three months. That way you can do the work or sell the product, bill it, and get it paid within six months.

If you do run into a cash crunch, there are two things you can do:

First, receive your receivables. Allowing clients to pay Net 30 (30 days after purchase) is common business practice. But anything more than that is bad business. If you consistently have outstanding invoices, change your terms. Always remember that accounts receivables (AR) are the lifeblood of your business, representing your business' cash flow and liquidity. Getting your receivables current therefore can bring in immediate cash.

Your other option for dealing with a cash crunch, ironically, is to get a loan. Sometimes you simply need a short-term infusion of cash to keep things going until business picks up again. A prudent loan with a plan to pay it back can be a smart solution to a short term cash crunch .

Pricing

Just how important is selecting the right price in your business? It could mean the difference between success and failure. The wrong price can put you out of business. Finding that magic number requires careful thought and planning.

There are basically two schools of thought when it comes to pricing your product or service (above your break-even point):

If you are more interested in growing rapidly and capturing a larger share of the market (called, of course, your market share) then you need to price your goods as low as possible because the laws of economics dictate that a lower price will attract more customers. Volkswagen sells far more cars than Mercedes, but Mercedes makes more money, per car. If you are going for a broad customer base, then you need to figure out, often by trial and error, what price people will consider a bargain, and which still allows you to make a profit.

However, if dominating the field is not your business model, if you are more interested in increasing profits, then you need to go with a higher price. It has to be near what the competition is charging yet high enough for you to live on. No, it's not always easy to figure out and yes it takes time.

Add into this equation the brand you are attempting to create. A big part of how people perceive your business is based on what you charge. Two lawyers may do the exact same sort of work, but the one who charges $350 an hour will be perceived as better than the one who charges $150 an hour. Yes, she will get fewer clients, but they probably are better clients.

Here is the analysis to go through to determine your fees and prices:

Determine your break-even point. Use the formula above to calculate your break-even point and start there.

Identify your customers and brand. Are your customers middle class or wealthy? Is your brand upscale, or not? Do customers want bargains or is quality more important?

What is the competition doing? Again, people look for bargains. If you can afford to beat the competition, all other things being equal, you will get business.

Don't set your price too low if you want to grow. The best source of cash for growth is a healthy gross profit margin.

Test, test, and test some more. Finding the right price will require trial and error. Tinker.

Increasing Your Profit

There are three ways for you to improve your profits. First, you can sell more. Second, you can increase your prices. Third, you can reduce your overhead.

Sell More: Of course, the best way to increase your profit is to sell more. Easier said than done, you say? Maybe, but that sais, you probably sell more today than you did five years ago. The trick is to duplicate what you have done right, continue to do that, be sure to add some new profit centers.

Increase Prices: Many small business owners are afraid to raise their prices because they fear that they will drive away customers. That may or may not be true. When you use price as the primary gauge for your services, then other, maybe more important factors, get left out of the equation - things like quality, personal service, convenience, or speed.

McDonald's and Wal-Mart emphasize low prices because that is their business model, and unless it is yours too, then constantly worrying about fees and prices is likely a mistake.

Instead, you need to decide what it is you offer that is best, and emphasize that. If price is not critical, then raising your prices is a smart way to increase profits. Think again about Mercedes - it does not battle on the cheapest-is-best battleground. Rather, it emphasizes quality, and makes a handsome profit in the process.

Because you are your own boss, you set the prices. When is the last time you raised your prices? While you should be justly concerned that you may drive away clients if you do, it is still worth a shot. If your fears are valid, you can always lower your prices again. But if your fears are ungrounded, you will be giving yourself a well-deserved raise.

By the way, if yours is a service business, simply consider testing a price increase on a few customers first. If they do not balk, then you can roll out your price increases across the board, and if they do, you can always roll back.

Reduce Your Overhead: The tried and true way to increase profit margin is to decrease costs. When a Fortune 500 company lays off 1,000 employees, they are utilizing this strategy. Of course the risk is that by cutting costs you may cut into the very thing that brings in business. That is a real danger. And that is why firing people usually is not the answer. What is?

You have to figure out a way to reduce your overhead, and more importantly, to have employees care about keeping costs down, because it is often your employees who hold the key to cost overruns. If you can get them committed to saving, then staying consistently profitable is much more likely. Is it easy? No. But with good communication and the proper culture, it does happen, and often.

Paying Yourself

A question many small business owners have vis-à-vis profitability is how much they should be paying themselves. When figuring out how much to pay yourself, the most important thing to consider is your business' financial condition. Before you can decide how much money you can safely pull out of the business each month, you need to first figure out how much money your small business needs, because its needs come first.

So you need to calculate your break-even point and go from there. Knowing how much comes in and goes out allows you to figure out how much you can realistically afford to pay yourself. How much is that? Only you can say for sure after seeing your budget, but as you begin to formulate that number, keep the following three things in mind:

Your business structure often determines when, and how, to pay yourself. As I have written here recently, are five forms your business can take: C corporation, S corporation, limited liability company (LLC), partnership, or sole proprietorship.

Only owners who have set their businesses up as C corporations are legally considered "employees" of the business. If your business is a C corporation, then you can pay yourself as you would every other employee - as part of normal payroll.

Many small businesses start their businesses as sole proprietorships or partnerships. Sole proprietors can pay themselves whatever they want; it depends almost entirely on how much profit you make, how much money your business needs, and thus what you can afford to pay yourself. Partners must consider the desires of each other when determining how much they will be paid.

The same is true for LLCs that have more than one owner, with one caveat: You can make a distribution of profits legally, only if doing so does not impair the solvency of the business.

Avoid paying yourself as the money comes in. Many small business owners make this mistake. If they have a good month, they take the extra out of the business, if they have a bad month, they don't. It is imperative that your business checking account always has enough of money in it so that if something goes wrong, you can afford to fix it.

If you pay yourself whatever comes in every month, saving for a rainy day will be impossible. The smarter thing to do then is to come up with a figure to pay yourself that your business can live with, and pay that amount to yourself on a consistent basis.

Consider the tax consequences. If you have a C corporation, when you pay yourself, the business is responsible for payroll taxes on the amount you get paid.

In the case of a sole proprietor and partnership, whatever profits the business makes "flows through" onto your personal income tax - your business' profits or losses are considered your personal profits or losses. Partners and sole proprietors are also responsible for the self-employment tax, which runs about 15 percent. Remaining profitable takes constant attention to detail. Keeping track of your margins and then increasing business or reducing costs as necessary is what is required.